Will law capping interest rates really protect the borrower?

In March 2016, Parliamentarians embarked on an a rather imperative plan to cap the skyrocketing interest rates on loans through what came to be the famous Banking Amendment Bill 2015, sponsored by Kiambu Member of Parliament, Jude Njomo.

Among the proposals in the Bill was to cap interest rates at not more than four percent of the base lending rate set by the Central Bank of Kenya.

But was this the best way to protect consumers? Are there other avenues available that could be explored to address the challenge of high interest rates?

Despite the loans attracting interest rates as high as 21 per cent, economists felt that the law would do more harm than good to borrowers; especially the low scale borrowers who form the majority.

Ideally, Njomo was against the capitalistic ideology of the banks that capitalize on borrowers to amass huge profits at the expense of borrowers.

The move by President Uhuru Kenyatta to assent to the Bill caught many lenders flat-footed despite the heavy lobbying to have it rejected.

Upon the assenting of the Bill by the President, some lenders – most of them middle-tier – immediately suspended issuing of new facilities awaiting a clarification from the Central Bank on how the law was to be implemented; retrogressively or otherwise.

Despite this, the banks immediately swallowed the bitter pill and capped all their facilities at 14.5%.

Habil Olaka, the Chief Executive Officer Kenya Bankers Association, however, argued that capping interest rates is a dangerous way of protecting borrowers.

“The problem is that it will create challenges that will be more damaging to the market than the original problem it is trying to solve. It will not bring the rates down if we don’t tackle the actual reasons why the rates are up,” Olaka was quoted as saying.

According to Olaka, a sustainable solution lies in all these factors being dealt with simultaneously and consistently.

“What I see is a good future, a bright future dependant on a number of factors. If we can be able to maintain our momentum in addressing those challenges, I think we will see the rates continuing to come down from where they are today.”

Basically, lending rates are determined by factors such as the cost of funds influenced by government’s borrowing trends, administration overheads (which vary from bank to bank), credit risk associated with a borrower, chances of defaulting and profit margin from each loan facility (which also vary).

In April 2016, the Central Bank of Kenya opposed the move by lawmakers to cap interest rates, arguing that it would be counterproductive.

CBK Governor, Dr Patrick Njoroge, argued that fixing interest rates would lead to collusion, with borrowers being forced to turn to shylocks for credit services.

The Federation of Kenya Employers (FKE) joined the “don’t sign call” bandwagon hoping to influence the President not to assent to the Bill, instead advocating for a comprehensive dialogue among the stakeholders.

While acknowledging that the cost of loans is beyond the reach of many, FKE was of the opinion that the matter should be deliberated further to find a lasting solution to the high interest rates.

“A negotiated process of bringing down the cost of credit will yield better results for all parties,” argued Jacqueline Mugo, the FKE CEO.

With the banks having to adjust to the new ‘normal’ and not looking like they are in contravention of the law, the banking sector may suffer huge job cuts and even closure of some branches.